Business Context and Reporting Period
Company: Herbalife Ltd.
Filing Type: Form 10-Q (Unaudited)
Period Ended: March 31, 2009
Business Overview: Herbalife is a global network marketing company selling weight management, nutritional supplements, and personal care products through over 1.9 million independent distributors in 70 countries. China is a separate reporting segment utilizing a retail store and employed sales force model due to local regulations.
Key Financial Metrics
| Metric (in millions, except per share) | Q1 2009 | Q1 2008 |
|---|---|---|
| Net Sales | $521.7 | $604.4 |
| Gross Profit | $419.3 | $486.8 |
| Gross Margin | 80.4% | 80.5% |
| Operating Income | $62.3 | $89.7 |
| Net Income | $41.5 | $62.4 |
| Diluted EPS | $0.67 | $0.93 |
| Operating Cash Flow | $86.0 | $62.8 |
| Cash and Equivalents (Ending) | $194.7 | $191.1 |
| Total Debt | $345.5 | $351.6 |
Material Changes vs. Prior Period
- Revenue Decline: Net sales decreased 13.7% year-over-year. This was primarily driven by a 12.8% adverse impact from foreign currency fluctuations. In local currency, net sales declined only 0.9%.
- Profitability: Net income fell 33.4% to $41.5 million. The decline was attributed to revenue drops, a higher effective tax rate (31.4% vs. 27.4%), higher depreciation, and foreign currency losses, partially offset by lower interest expense and restructuring savings.
- Geographic Performance:
- Declines: Mexico (-36.8%), South and Central America (-29.0%), and EMEA (-22.0%) saw significant drops due to currency headwinds, VAT increases in Mexico, and volume declines.
- Growth: Asia Pacific (excluding China) grew 9.9% (29.8% in local currency), driven by Taiwan, South Korea, and Malaysia. North America grew 3.8%.
- Cost Structure: Royalty overrides as a percentage of net sales decreased to 33.7% from 35.2%, largely due to the growing proportion of sales in China where employee compensation is classified as SG&A rather than royalties.
Guidance, Outlook, and Risks
- Outlook: Management expects fiscal year 2009 net sales in North America to increase due to a shift to a daily consumption model and a 5% price increase. Conversely, sales in Mexico and South/Central America are expected to decline due to VAT charges and currency fluctuations. Asia Pacific sales are projected to be flat due to currency headwinds offsetting volume growth.
- Capital Allocation: A share repurchase program expired in April 2009. A new program was authorized on April 30, 2009, to repurchase up to $300 million of common shares over two years. A quarterly dividend of $0.20 per share was declared for Q1 2009.
- Key Risks:
- Currency & Venezuela: Significant exposure to foreign exchange rates. Specific concern regarding Venezuela's currency restrictions, which limit the repatriation of cash at official exchange rates. Venezuela holds approximately $43.9 million in cash (in bolivars).
- Regulatory: Ongoing tax audits in various jurisdictions and potential changes in direct selling regulations, particularly in China and Europe.
- Distributor Turnover: High turnover is inherent to the business model; retention rates for supervisors were 40.3% for the re-qualification period ending January 2009.
Investor Verification Checklist
- Foreign Exchange Impact: Verify the sensitivity of future earnings to USD strength, as currency fluctuations accounted for the majority of the reported revenue decline.
- Venezuela Liquidity: Assess the risk of impairment or write-downs related to the $43.9 million cash balance in Venezuela if the country is designated as highly inflationary or if repatriation remains blocked.
- China Growth Model: Monitor the transition of the China business from retail stores to a direct selling model and the associated regulatory licensing progress.
- Share Repurchase Execution: Track the utilization of the newly authorized $300 million share repurchase program.
- Tax Contingencies: Review the status of pending tax audits and the $41.1 million in unrecognized tax benefits.